1. Maximize your retirement savings
Retirement is the single most important long-term financial goal for most investors, but did you know that investing for retirement is also one of the best ways to save on taxes? If you contribute to your employer’s workplace savings plan, it helps reduce your taxable income, and any earnings on your account accumulate tax-deferred until withdrawal. Depending on if you are eligible to save for retirement at work and your income level, you may be able to deduct your annual contribution to a Traditional IRA. And if your household income is less than $156,000 ($99,000 if you’re single), you may be eligible to contribute fully to a Roth IRA.

Roth contributions aren’t tax deductible, but after five years and after age 59½, withdrawals from a Roth IRA are tax free for life—and beyond. For calendar year 2007, you and your spouse can contribute up to $4,000 to an IRA, $5,000 if you’re 50+. In 2008, the contribution limits rise to $5,000 and $6,000 respectively. 

2. Manage your capital gains
Most stock mutual fund managers buy and sell holdings, seeking to generate the highest possible returns for shareholders. When stocks are sold at a profit, the fund books a capital gain, which it passes on to shareholders. However, you may be able to lower the tax bill on funds in your taxable portfolio by keeping the timing of capital gains distributions in mind. If you’re thinking of investing in a fund that is not currently in your portfolio, avoid investing right before a distribution is declared. otherwise, you’ll inherit the capital gains distribution—and the tax liability. Most funds distribute capital gains just once a year—in November or December—so tuck this information into your calendar for the end of the year. That said, don’t let future taxes stand in your way of your regular investment plan. Taxes are important—but they are only one part of the equation.

3. Take a closer look at tax-exempt funds
Some funds take tax savings one step further and pay income that is generally free from federal income tax, and may also be free of state income tax. Tax-exempt municipal bond funds invest in bonds issued by state, city and municipal institutions, such as universities, hospitals and airports. They typically yield less than taxable bond funds. However, you may actually end up with a higher return depending on your tax bracket.

There’s an easy way to figure out whether a tax-exempt bond fund is right for you. Here’s how it works. Let’s say that your marginal income tax rate is 28% and you are considering investing in a tax-exempt bond that yields 4.0%. How much would you need to earn from a taxable bond to equal a 4.0% yield? This simple calculation provides the answer: 5.5%. Tax exempt funds are even more attractive to investors in higher tax brackets. With a 35% marginal tax rate, the taxable equivalent yield rises to 6.1%. Keep in mind that tax-exempt funds are only appropriate for your non-retirement portfolio. A portion of the income may be subject to state and/or local taxes and capital gains are fully taxable. Also, some investors may be subject to the federal Alternative Minimum Tax (AMT).